Wage stimulus in northern Europe not helping to restore trade balances in peripheral countries

Discussions about trade imbalances in the euro area have not been focusing only on the deficit countries, but also on the extent to which responsibility for bringing about change lies with countries, such as the Netherlands, that are running surpluses. Various economists argue for higher wage increases in the Netherlands and other surplus countries in order to speed up the adjustment of imbalances in the EMU.

Analysis of the trade flows shows that the widening of the peripheral countries' trade deficits over the past decade largely reflected the stronger trade with non-euro area countries (see Figure, click to enlarge). Indeed the Netherlands and Germany's share in imports from the peripheral countries has actually fallen or remained the same in recent years. Their share in the peripheral countries' trade deficit has hence shown little if any increase. Moreover, the Netherlands and Germany do not compete much with the peripheral countries on third markets because of the vast differences in their export products.

Exports of Dutch gas and German cars are not in serious competition with southern European export products such as tourism, textiles and agricultural products (wine, olive oil). The difference in the export mixes partially explains why external developments such as the emergence of China and the rising oil prices have had widely divergent effects on the trade balance of the euro area countries. The peripheral countries have been hardest hit by competition from China in their export markets as their exports have more often been replaceable by Chinese goods, while their imports from China have also risen relatively sharply. Germany in particular has benefited from higher demand from China and central and eastern Europe for exports of machinery and equipment, for example, while the Netherlands benefits from its role as a mainport for Europe. The rising oil prices have also had wide-ranging effects: whereas Italy and Spain have seen a significant worsening of their trade balances, Germany has benefited from higher exports to oil-exporting countries and the Netherlands, thanks to its gas exports, is less vulnerable to oil price shocks.

Analysis by DNB confirms that higher wage rises in the Netherlands and Germany will bring little if any improvement to the trade balances of the peripheral countries. According to the international economic model NiGEM, a simultaneous extra wage increase of one per cent in the Netherlands and Germany would even cause a slight deterioration in the peripheral countries' trade balances. One reason is that while employees would indeed receive a boost to their purchasing power, unemployment is rising at the same time and investment is falling. These effects temper domestic and external demand in northern Europe, narrowing the opportunities for the peripheral countries to sell their products in northern markets.

Improving the trade balances of peripheral countries is therefore not a strong argument in favour of a wage stimulus in northern Europe. The trade balances of peripheral countries will probably show little if any improvement as a result of an extra wage increase in the Netherlands and Germany. At the same time, however, unemployment in the Netherlands and Germany is rising. As the euro area is an open economy, it is important that both the individual countries and the euro area as a whole remain competitive. In order to narrow their trade deficits, peripheral countries must improve their competitive position vis-à-vis the rest of the world – including the world beyond the euro area. Besides wage restraint, structural reforms are also needed to make their economies more competitive.